Guaranteed auto protection (GAP) programs have grown in popularity with both lenders and borrowers during the past five years, but changes on the supply side of the business could cause concerns for many credit unions.
The reasons for these marketplace shifts are fairly simple: Many GAP providers did not devote the resources necessary to manage their programs properly, so if claims suddenly spiked, the companies did not have the financial resources to cover the losses. As a result, these providers were forced to either implement rate increases (often assessed on all GAP clients regardless of claims history) or to cease offering the product altogether.
These developments come at a time when GAP programs are increasingly popular-not only with borrowers, but also with lenders. In addition to being able to protect the outstanding balance of an automobile loan, credit unions welcome the non-interest income generated by GAP programs, as well as the goodwill that is often developed with their borrowers. So in order to preserve these benefits, credit unions are beginning to scrutinize their GAP providers more closely to ensure that they are committed to serving this segment of the market and have the necessary resources and processes in place to sustain that commitment.
The History Of GAP
GAP-which first appeared about 15 years ago and is now a staple part of most automotive lending programs-was designed to provide borrowers, and ultimately lenders, with added protection in the event the financed vehicle is lost due to an accident or unrecovered theft.
The value of a new vehicle depreciates sharply within the first two or three years of ownership, much faster than the loan or lease balance.
If the vehicle is involved in an accident and is declared a total loss or if it is stolen, the borrower might not be able to pay the difference between what his or her automobile insurance pays and the remaining balance on the loan/lease.
For a fee, typically a few dollars added to the monthly payment, the GAP addendum pays the rest of the outstanding balance, potentially saving the borrower thousands of dollars that would otherwise be an out-of-pocket expense.
Carriers offer GAP policies to credit unions, which in turn sell GAP addenda to borrowers. The difference between the lender's cost and the amount charged to the borrower is recorded as non-interest income for the lender.
These programs have become more popular with borrowers in recent years because the "gap" between the market value of the vehicle and the loan/lease balance has become more significant.
There are several reasons for this trend. Used-car values are lower than they have been in the past because more consumers can afford to purchase new vehicles because of low interest rates and special offers, thus decreasing the demand for used cars.
These low rates and other incentives, such as "no-money-down" promotions, are leading consumers to finance a larger portion of the purchase price.
As a result, the borrower has a larger risk exposure for a longer period of time should the vehicle be totaled or stolen and not recovered.
"GAP is a product born of conditions in the marketplace," said Patrick Adams, executive vice president of the St. Louis Community Credit Union. "People don't have money down on vehicles, so there's a high loan-to-value ratio. Couple that with the steep depreciation of vehicles, and this product was born."
As significant as the benefits of a GAP program are for borrowers, there are greater advantages for lenders. Perhaps the most obvious benefit is that the GAP addendum eliminates the potential that a financing arrangement would have to be written off in the event that a vehicle sustains a covered loss and the borrower is unable to pay the full outstanding balance. The coverage also streamlines the collection process so the lender can avoid additional costs, such as collection and legal fees.
Lenders are motivated to sell GAP addenda because a high penetration rate among borrowers often equates to a lower risk of defaults. And, indeed, penetration rates have been rising, although there is still significant room for improvement.
GAP "helps to eliminate potential dealings with deficient balances that might result from certain circumstances," said Ted Zangwill, Senior Vice President of Lending at Space Coast Credit Union, a Melbourne, Fla.-based credit union that has been offering GAP to its members for about four years. "It helps eliminate some problems that could affect our bottom line if we were to have those types of claims."
A Larger Opportunity
St. Louis Community Credit Union's Adams noted that because of his institution's location, selling GAP was very important. "We're an urban-based credit union and many of our members leave their cars parked outside and there are all kinds of urban-related dangers out there," he said, pointing to increased likelihood of accidental damage to a greater possibility of theft. "We felt we had an even larger opportunity to experience losses. We think it's a win-win type of product. It's good for our members and it's good for the credit union."
Another benefit for lenders is the non-interest income stream generated by the sale of GAP policies. "If a credit union manages its loss ratio, holds down the cost of the addenda and continues to float with the market on the price to members, it could make some real good money," Adams said.
Typically a financial institution doesn't charge borrowers as much as dealerships do for GAP, but there are still reasonable margins available. "It's probably, in some cases, about half of what a dealer would charge," said Zangwill. "I think that's why we're having the success we are in terms of penetration."
A third benefit of GAP is the goodwill generated among borrowers toward the lending institution. While the addenda offer consumers protection against potentially thousands of dollars of loss, the small fee goes virtually unnoticed by the borrower-until they lose their vehicle.
The protection that GAP offers is particularly important for borrowers with limited discretionary income, St. Louis Community Credit Union's Adams said.
"The impact of the loss of a vehicle, particularly in that initial depreciation period, is huge for those individuals," he added, noting these consumers are especially appreciative of the protection. "It's an affinity for our credit union. It's absolutely a value-added feature when properly packaged and put forth at the loan desk," Adams added.
What to Look for in a GAP Provider
Because the stakes are so high for credit unions, it is imperative that they select the proper carrier for their GAP program. There are some key qualities that a GAP provider should possess. They are:
A commitment to the marketplace. Many large companies have withdrawn from the GAP market, so a credit union should make sure their provider has the resources and stability to withstand fluctuations in claims activity.
This is important for several reasons. For example, when a borrower files a claim under a GAP addendum it means he or she has experienced the loss of his or her vehicle, an emotional and disconcerting time for most people. Credit unions do not want to exacerbate the situation and will want to facilitate the claims filing process as much as possible.
This is more easily accomplished when the credit union is working with a carrier with which it has had a long-standing relationship.
One way to determine if a carrier has the ability to remain an active player in the GAP market is to look at how it prices its program. If the provider is using a single rate for all lenders, there is a chance that the carrier might be underpricing some of its programs and leaving itself exposed to claims that exceed its financial resources.
A commitment to technology.
Technology tools are an important part of selling and administering GAP programs. It is vital that a credit union's carrier make significant investments in developing technology solutions that will help a lender in these areas.
A borrower might not understand the value in purchasing a GAP addendum in the first place.
Being able to graphically show a borrower his or her exposure during the initial years of the loan or lease could be just the thing to close the deal.
For the lender, technology can play an important role not only in assessing its exposure to potential losses, but also in completing the necessary paperwork for thousands of GAP addenda.
While technology is one part of meeting a client's needs, it must be accompanied by a personal touch.
Often, a carrier may need to help its lenders get the most out of their GAP programs through training and other services.
For example, a lender might need to be walked through the claims filing process or require assistance in identifying ways to increase the GAP penetration rate among its members.
GAP has become an important part of credit unions' lending programs. But, as the product has grown in popularity, there have been significant developments on the carrier side of the marketplace.
As a result, lenders are well advised to select a GAP provider with adequate financial resources, innovative technology tools and dedicated customer service teams to ensure that the firm will remain a valuable partner for years to come.
Francine Gagliano is GAP product manager for State National Companies, a GAP underwriter based in Fort Worth, Texas.
